Kua`aina Partners
Through a Glass Darkly (Perspectives)

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By hedden
February 26, 2001

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

For now we see through a glass, darkly, but then face to face: now I know in part; but then shall I know even as also I am known.
-1st Corinthians, verse 12.

A recent article in SmartMoney referred to the "Nasdaq Apocalypse", and with sentiments like those below, perhaps biblical references don't seem so out of place. Putting aside notions of the afterlife, what the quote above points out is that here in the present moment, we are all limited in our vision. The future is seen only as though through a dark glass. Restating for financial relevance, perhaps we could say, "For now we look forward through projections, models, expected earnings, and extrapolated trends; knowing only insofar as our assumptions allow. But then shall I know the returns even as also my companies values are known."

From CBS Marketwatch:
"The stock market bottoms about two and a half months after the first Fed ease; then the market leads the trough in the economy by five months and the profits trough by eight months. Since the stock market hasn't bottomed, we're now looking for down earnings-per-share this year and later a recovering stock market driven by aggressive Fed ease and multiple expansion," Applegate said in a note to clients.
On this forecast, Applegate said he now expects returns for the year of 22
percent for stocks, 11 percent for bonds and 5 percent for cash.

I find this kind of prognostication completely disingenuous. This analyst speaks as though he has a crystal ball, but tells us nothing about the assumptions that drive the statements. Why should the market bottom 2 � months after a Fed ease, why not 3 or 4 or 7 4/18 months? The best we can do is to judge Applegate and the other pundits by the accuracy of their statements, and then ignore them once their forecasts turn out to be wrong too often.

For anyone needing evidence to begin doubting the motives and accuracy of analysts, here are two posts I recommend. The first is a recent look at Blodget's calls, and the second is a more academic investigation of how analysts make recommendations.
Ted in 10599:
I hope the market turns soon. I've had enough.

2old4bs in 10616:
I sold the last of my stocks this morning. I am taking a hiatus--perhaps for 2 weeks...perhaps for 2 years. I can't stand the thought of having my life revolve around the market anymore. I too have had enough.

The general tenor across a variety of message boards echoes these comments. It is very easy, and perhaps justified, to be discouraged in the face of large losses. Certainly if you were expecting continual yearly gains of 15+% (from polls in 1999 and 2000), a loss of capital can be a stunning blow.

But we knew (or should have known) at the time we put our money on the table in 1999 and early 2000 that not only were the market indices at or near all time highs, but trading volume and average volatility were also at all time highs. This means that we should expect more rapid shifts in sentiment and larger price changes (up or down) than ever before. Now that those price changes are happening in a negative direction, we become disheartened, and, more importantly, we begin to make decisions based on our discouragement.

Some are even using the downturn to proclaim the death of Long-Term Buy and Hold as a strategy. For instance, this story from SmartMoney questions the LTBH school compared to trading.

An excerpt:
Investors who preach "buy and hold" are kidding themselves. What the long haul speaks to isn't the merits of stocks as an asset class, but the mathematical effects of compound interest over time. The point of the long haul isn't that stocks will go up over time, but that even low levels of return will eventually create wealth as a result of consistent compounding. Fair enough. The problem is that "eventually" can be an awfully long time. So-called prudent investors have been misled by believing that stocks return about 12% a year. But that oft-quoted statistic actually represents a 72-year average - and I for one am uncomfortable waiting around that long to see if history repeats itself.

What this author is missing is that not only does compounding create wealth over long periods of time, but also that higher average rates of return create exponentially more wealth the longer the investment time frame. And equities have been shown historically to outperform every other asset class over any period of time greater than just 30 years (and something like 90% of the time over 20 years), not 72. If you have less than a 15-20 year time frame (and by this I mean that you should plan on not needing any of this money before 15 years is up), LTBH may be the wrong investment strategy for you, simply because you do not have the ability (in terms of time) to let compounding work its exponential wonders. If you do have a truly long-term investment horizon, then perhaps it is time to revisit Siegel's Stocks for the Long Run to remind yourself of why equities are the investment of choice.

Another excerpt:
Think trading is dangerous? Try buy and hold. In my experience, the long haul is really just an excuse for leaving problems in your portfolio untouched and ignored. It encourages us to let trades become investments simply because we were wrong in our analysis. The long haul is what prompts people to buy XYZ at 100 expecting it will go to 120. But when it slides to 50, they wait...and wait...and hope...and wait, because we've been told that most stocks eventually go up and hey, we're in it for the long term.

It's absolutely correct to say that one should never ignore an investment just because you have planned for a long time frame. For any investment (other than an index proxy) to be worth holding, you should genuinely expect it to provide a higher than average return (indexes can be expected to provide an average rate of return). Once something changes about the prospects of the company (and I don't mean just a price decline), that causes you to project a below average rate of return, its time to move that money to an index or to a better investment idea. Just because in practice, some investors ignore problem stocks does not invalidate LTBH as a strategy.

50nBroke in 10623:
I am closing in on a $10,000 lost since May 2K.
This is a 50% loss of my total capital in 9 months.
College and grad school didn't cost me that much.
Now that I have paid the tuition for LTBH school I am trying CANSLIM. I made 27% in 4 days on my 1st trade. Nineteen more and I am even.

I don't want to belittle anyone, but as you can see from my statements about time frames above, 9 months is not LTBH. Similarly, one trade does not make a successful strategy. What each of us needs to work out on our own is whether we are comfortable with the risk, the potential reward, the time frame, and the theoretical underpinnings of any given strategy. Only if we can honestly affirm our comfort level with each of these aspects (among other aspects that may be unique to any particular strategy), should we even begin to employ that strategy in our own investing decisions. You shouldn't just perform due diligence on the companies you invest in, you should perform DD on the strategy you invest with.

Back to Ted:
So I went surfing through the Kua`aina Partners board to look at sentiment from March of 2000 and get some perspective.

Ted's instincts are excellent. Looking through the back posts of this board is perhaps one of the best possible ways to regain perspective. The members of this board have excelled in two primary areas: 1) in thinking openly about the investment strategies they choose, and 2) performing detailed company-specific analysis. In my opinion, this is exactly what will lead to investment success, regardless of overall market conditions. As they say, in a bull market, everyone is a genius. But if you can use market downturns to find "insanely great" companies at undervalued prices, then your chances of success are excellent. The trick is in having the stamina and confidence to recognize values when everyone else is selling. In my experience, my worst "speculations" (yes, even I have occasionally been guilty) have been when I bought on the fundamental glories as expounded by others on the boards and in the press. My best investments have been when I got to know a company to the point that I was confident in its management, historical performance, and my future expectations for its growth - but even then, I did not purchase shares unless my valuation methods (most notably DCF), validated the price. Now, even some companies that I have lusted after on the fundamentals are nearing or have already dropped below what seemed like ridiculously low buy-in points a year ago. Of course, I won't know if those buy-in points based on estimated value were really reflective of those companies' prospects for several more years. In general, I don't think that the recent market action tells us anything about any of the particular strategies usually discussed on this board. A down market doesn't invalidate strategies like RB, RM, GG, intrinsic value, or TA. All it really does is remind us to be careful and to keep in mind the importance of the strategy. Modifying your chosen (and hopefully sound) strategy to chase after high fliers is a dangerous game indeed. It has also increased the awareness of valuation in general at TMF, which I regard as a good thing.

Phileo in 10633:
In a way, the index is a gauge of investor sentiment. Back in 1999-2000, investors were confident, as reflected in the overvaluation and over-bidding of stocks. Now, investors are clearly not confident, as the 'Naz keeps going down day after day. I don't know about you, but when I look at the market action in the past couple of weeks, with failed rally attempts, it just gives me more bearish sentiments.

And from CBS Marketwatch:
"They liked Nasdaq at 5,000 and now they hate it near 2,000. For the first time in 2 and a half years you can own tech stocks [at more attractive] valuations," observed Peter Boockvar, equity strategist at Miller Tabak & Co. Long-term investors can take advantage of this situation, he said, though the market will likely remain dicey in the near term.

When the direction of the market gives you bearish sentiments, I believe you may be trapped in a dangerous mindset - that of a follower. I don't advocate being a "leader" in the sense that you should buy in hopes that others will follow. Individual investors simply don't have the influence or the monetary backing to play that game. Instead, your bullishness or bearishness should be largely uncorrelated with the direction of the market. (I say largely because the price of a stock, which will be affected by the market, should play a role in your evaluation of its worth as an investment.) Real success comes from being able to consistently recognize what others fail to see. There may be multiple methods for doing so, but find one that works for you and apply it consistently. This will often mean buying when everyone around you is screaming "Fire" and running for the exits. If you can, wait until nearly everyone else is out, but before the fireman gets there and says, "There's no fire after all. It's safe to go back in." If you aren't confident that you can do so using a method you are comfortable with to evaluate companies you understand, then you may want to consider an index fund. Remember also that it may take several years before you can determine whether you were right or wrong. This is especially true for strategies like LTBH or intrinsic value analysis, which rely on long-term growth trends in company fundamentals.

Try to keep this all in perspective, and use this time to continue to learn. Search especially for opportunity whenever it may present itself.

Let me leave you with a quote from Warren Buffett, about looking through that dark glass toward the future:
The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.